During the week of September 26th thru October 3rd, the “bid” prices for: gold fell 3.7 % to $834.80; silver fell 16.1 % to $11.16; platinum fell 12.6 % to $962; palladium fell 12.2 % to $195; DJIA fell 7.3 % o 10,325.40; NASDAQ fell 10.8 % to 1,947.39; NYSE fell 10.1 % to 7,088.94; crude oil fell 12.8 % to $93.22—but the US Dollar Index rose 3.87 to 80.83. Last Friday’s markets showed that the prices of virtually all U.S. stock indexes and commodities fell; that the only “winner” was the dollar index—which rose by a spectacular 3.87 points.
Undeniably, the dollar is rising in value while virtually everything else is falling. That’s deflation—the hallmark of an economic depression and the absolute contradiction to 70 years of U.S. monetary policy: intentional inflation.
Inflation can be troubling, but deflation is deadly. Why? Because during periods of deflation, people—realizing that their dollars will be worth more tomorrow than they are today—tend to save rather than spend. The result is a loss of sales, diminished production, job layoffs and further price declines.
The deflationary spiral feeds on itself and is extraordinarily difficult to escape. The last time we went into a serious episode of deflation (circa A.D. 1929), we didn’t get out until somebody started WWII. I.e., we needed a world war to jump start the economy with the sudden increase in demand and production for war machines to escape the deflation of the 1930s. Deflation is not only figuratively “deadly” to your economy—it can literally kill millions of men and women.
Why is deflation happening today? Hard to say. The economic engine of the United States and even that of the global economy had been the American home and mortgage industry. Mortgages were bundled, sold, and used to “bond” other investments. The resulting “leverage” supported much of the world’s economic growth. However, so much depended on the mortgage business, that the prices of homes were allowed to appreciate to unreasonable and then irrational levels. When reason finally began to prevail, the sudden fall in the price of American homes unleashed a deflationary avalanche that can only be stopped (if at all) by massive countervailing monetary inflation (or perhaps WWIII).
Last week, the Dow Jones Industrial Average fell by 817 points (over 7%) and simultaneously wiped out about $1.3 trillion dollars in paper equity. Thus, in just one week, the DJIA alone “vaporized” almost $1.3 trillion dollars in paper equity. As the prices of other market indexes and commodities also fell, additional billions and probably trillions of paper equity were also wiped out.
The significance of these massive paper losses are two-fold:
First, most these trillions of dollars in paper equities and commodities were almost certainly used as collateral to “leverage” other loans and investments. Therefore, once the Dow “vaporized” $1.3 trillion, these “vaporized” equities and commodities could no longer be used as collateral. Once this collateral “vaporized,” the loans, investments and construction projects built on this collateral would also be compromised and even terminated. In a debt-based, fiat monetary system, when the value of debt instruments disappear, the loss doesn’t merely affect the holder, but causes a ripple effect that slows the entire economy. That leads to economic depression.
Second, in our modern fiat monetary system, debt instruments like stocks and bonds tend to function just as much as a kind of “money” as Federal Reserve Notes (cash). Therefore, when the value of debt instruments is vaporized by the market, the total supply of “money” in circulation is proportionally diminished—and more importantly, the value of the remaining “money” is necessarily increased.
For example, suppose our total money supply were $1 trillion—half in cash, and half in debt instruments (stocks, bonds, etc.). Suppose the markets wiped out half the value of the debt instruments. The total “money” supply would be thereby reduced by 25%. The relative value of the remaining cash would have to increase.
It’s simple supply and demand economics. Suppose the supply of oranges was reduced by 25%. The value and/or price of the remaining oranges would necessarily be increased. Same is true with “money”. When the supply of money is decreased, the value or “price” of whatever money remains must be increased.
That’s why the dollar is currently gaining value.
As the equity markets fall, the “supply” of monetary value represented by debt instruments (part of the money supply) also falls. As result, the relative value of the remaining supply of U.S. dollars (cash) must rise—even though the dollar is inherently worthless.
This is no cause for celebration. As the dollar index rises, our economy plunges more quickly toward a depression.
I believe the market declines and associated loss of the supply of “money” explains the sudden, desperate need for the $700 billion “bailout”. That bailout is essentially an attempt to inject an extra $700 billion into the economy and thereby inflate the supply of currency. The $700 billion in inflating currency is intended to compensate for the deflating currency—stock, bond, commodity debt instruments that are losing value and being “vaporized” by the markets.
If I’m right, what are the chances that the $700 billion bailout/injection will succeed?
About Zero.
Too little, too late. First, the $700 billion is not expected to be begin to “kick in” until after the November election. I expect this mess will have unfolded so quickly and dramatically in the meantime, that the $700 billion will be about as effective as sending an ambulance for someone who died last month.
Second, I suspect that Secretary of the Treasury Paulson calculated that $700 billion might be sufficient a couple of weeks ago. Three weeks ago, $700 billion might’ve been enough to make a difference. Today, the $700 billion is clearly a pittance relative to the problem. Note that just last week, the DJIA—alone—fell 817 points and thereby vaporized almost $1.3 trillion in paper assets. $700 billion is only about 55% of what was lost in just one week on the Dow.
And what about all the lost value of debt instruments on the other markets? Odds are that $700 billion won’t amount to more than 25% of total market losses last week. And that $700 billion was intended to last for at least several months.
Right now, I’d guess that we need an “instant” injection of at least $3 trillion (maybe $5 trillion) to re-inflate our economy and stop deflation. I doubt that our government can directly provide that “extra” $3 trillion in hyper-inflation, but it could “encourage” and “allow” a comparable injection of currency from foreign sources.
For example, China’s central bank is said to be sitting on at least 1.3 billion in U.S. dollars. In the past, some have feared that China would exercise the “nuclear option” and release all those dollars at once, causing massive inflation and a fall in the value of the dollar. But today, an extra $1.3 trillion would go a long ways towards re-inflating the deflating U.S. economy. An extra $1.3 trillion might slow our slide into a national and even global depression.
Other central banks also hold several trillion U.S. dollars as their “reserve currency”. If they were “encouraged” to release those dollars by purchasing U.S. stocks, bonds, commodities, etc., and thereby flooding the U.S. economy with “extra” dollars, we just might be able to stave off a national and then global depression. Unfortunately, to absord all that foreign currency into the U.S. economy, we’d have to carve this country up like a Christmas turkey as we sold asset after asset to foreign investors. Americans wouldn’t understand or approve. Political heads would roll. You can bet that no one running for office about four weeks from now is going to suggest we encourage foreign banks to push their reserve dollars back into the U.S. economy. After the election, someone might talk about asking the foreign central banks to buy up America, but if they do, it’ll probably be too little, too late.
Even if our politicians encouraged foreign central banks to return the reserve currency to the US, would foreign central bankers do so? Or—recognizing that those dollars are growing in value due to deflation—would foreign central banks postpone “saving the world” and hold their dollars to gain maximum purchasing power a month or year from now?
In other words, would the foreign bankers buy a stock priced at $100 today to save the economy if they figured they could get the same stock for $50 in a few months? Probably not. Would you?
If foreign bankers wait to re-inflate the U.S. dollar and U.S. economy, we’re probably heading straight into a U.S. and global depression. Later, when the central banks finally begin to buy up U.S. corporations, commodities and resources for ten cents on a dollar, this nation’s corporations will be essentially “balkanized” and the U.S. may cease to exist as a global power. (I.e., what happens when China and Saudi Arabia buy controlling interest of two or three of the major U.S. corporations that produce our military technology?)
We’ve worried for a decade about the “terrible” inflationary potential if “reserve currency” dollars held by foreign central banks were suddenly released. But in the end, the threat of deflationary dollars coming home to roost is far more damning. Inflation is troubling. Deflation kills.
By allowing our government to violate the Constitution’s mandate that “No State shall . . . make any Thing but gold and silver Coin a Tender in Payment of Debts,” we have unwittingly allowed our nation to risk catastrophe and even destruction. That catastrophe flows from a lack of fixed values.
Our government doesn’t have enough resources to single-handedly inflate the U.S. dollar out of the current deflation. Foreign central bankers might sacrifice their “reserve currency” dollars to stave off a depression—but given that those dollars are growing in value, I doubt it.
If we had a currency backed by gold or silver and thus with a fixed value, our government could officially devalue (inflate) the currency by declaring that the price of gold were suddenly doubled. But, given that our currency “floats” without any fixed value, we don’t even have an obvious ability to inflate by official devaluation.
A couple more weeks like the last one and we may be in an almost inescapable national and global depression. Truth is, the depression may already be inescapable.
So, what can we do?
Hang on tight.
